Preparing Your Investment Portfolio for the Washington State Millionaire's Tax

Washington's new personal income tax, widely referred to as the "Millionaire's Tax," represents a major tax hurdle for high-earning Washington residents. Signed into law by Governor Bob Ferguson, it imposes a flat 9.9% tax on taxable income exceeding $1 million per household impacting many of our Bellevue and Issaquah area clients. Additionally, many tax and legal experts expect the $1 million exemption to be lowered in the future, causing the tax to affect an increasing number of Washington state residents. On the bright side, there is a two-year window in 2026 and 2027 before the tax goes into effect in 2028 to prepare. Although some taxpayers are considering moving to more tax-friendly states, many do not have the option or desire to do so. Here are concrete strategies that may help prepare your investment portfolio for the upcoming millionaire's tax.

How the Millionaire's Tax Impacts Investment Income

This new tax applies to most forms of taxable income, including wages, profit distributions, dividends, interest, and most capital gains. The state's existing capital gains tax remains in place, but it allows for a deduction of the taxable amount of capital gains against the millionaire's tax, which adds an extra layer of complexity. However, because this new tax extends directly to dividends and interest from investments, finding opportunities to shelter and protect your portfolio is vital. The following strategies are ones that we use for many of our high income Issaquah, Bellevue, and Seattle area clients that can bring significant tax savings when the new tax is implemented.

Tax Strategies

1. Switch Municipal Bonds to Washington State and Local Issued Bonds

This new tax creates a major structural advantage for municipal bonds issued by entities based in Washington state. While municipal bond interest is generally exempt from federal tax, current rules dictate that all out-of-state municipal bond income must be added back to your state taxable base, subjecting non-local bonds to the additional 9.9% tax for those with income over $1 million.

By transitioning municipal portfolios away from nationwide issuers and focusing solely on Washington state and local bonds, investors can protect the municipal portion of their portfolio entirely. There is also time urgency to this move. As more investors realize this tax-saving opportunity, capital will likely flow heavily into Washington state municipal bonds over the next several years, pushing yields down. This pattern has already played out in high-tax states like California and New York. By acting early, investors have the opportunity to lock in more attractive yields while they last.

"For high-net-worth investors, switching your municipal bond portfolio to state domiciled issuers should be the biggest action item from this new tax bill. I cannot understate how impactful this is."

2. Shift Taxable Income-Producing Investment Strategies Into Tax-Sheltered Accounts

Different investment strategies carry vastly different tax burdens. Popular income-generating assets, such as dividend-focused stock funds, corporate bonds, or Treasury bonds, generate annual income that will be subject to the Washington State income tax. Rebalancing investment accounts to shift these income-heavy strategies into tax-sheltered accounts, such as 401(k)s, traditional IRAs, or Roth IRAs, ensures that the income is no longer exposed to the 9.9% tax. Meanwhile, keeping tax-efficient strategies like growth stocks or local municipal bonds in standard taxable accounts creates a well-optimized, tax-aware asset allocation.

3. Utilize More Tax-Efficient Investment Vehicles

In the investment world, vehicle structure matters just as much as asset selection. Although three different investment vehicles might hold the exact same underlying assets and deliver similar gross returns, their net tax efficiency can vary dramatically. The three most common structures are Mutual Funds, Exchange-Traded Funds (ETFs), and Direct Indexing or Separately Managed Accounts (SMAs). As a rule of thumb, Direct Indexing and SMAs offer the highest level of tax efficiency, followed by ETFs, with traditional mutual funds lagging behind due to mandatory capital gain distributions. Transitioning a portfolio into more tax-efficient structures helps minimize annual tax drag without altering your core investment strategy.

This Article on our website has more information about Direct Indexing.

4. Leverage Donor-Advised Funds (DAFs) or Charitable Remainder Trusts (CRTs)

Along with the new income tax comes a strict $100,000 cap on local charitable deduction exemptions. For individuals with larger or non-local charitable goals, utilizing a charitable vehicle like a Donor-Advised Fund (DAF) or a Charitable Remainder Trust (CRT) allows you to secure upfront federal tax deductions while realizing capital gains tax-free within the charitable entity. This approach is particularly effective during high-income years, such as when liquidating a large position in concentrated stock or selling a business.

"For an added bonus, if the DAF or CRT is principally managed and directed in the state of Washington, the contribution has the potential to be used toward the $100,000 charitable deduction limit allowed in the Washington State tax code."

Click Here for more information on how DAFs can be used as a charitable giving and tax reduction strategy.

5. Realize Capital Gains Prior to 2028

Because the tax does not take effect until 2028, a strategic two-year window exists in 2026 and 2027. Certain investors can benefit from deliberately realizing capital gains now at current tax rates, avoiding the additional 9.9% state tax layer that will apply in future years. While gain harvesting requires careful modeling and intentionality, it can yield substantial lifetime tax savings for high-income households. Although there is a refund for the current Washington State capital gains tax under the Millionaires Tax rules, in many scenarios capital gains will end up being taxed at higher rates once this goes into effect.

6. Exercise Stock Options Prior to 2028

For the same reasons described in strategy #5, it may make sense to exercise workplace stock options before 2028. Exercising options with a large bargain element can generate significant taxable income. Beginning in 2028, that income may be subject to Washington State income tax if your household falls above the $1,000,000 level. Exercising in 2026 or 2027 effectively avoids that additional tax.

Implementing These Strategies

If you believe one of these approaches could benefit your financial situation, work closely with both a knowledgeable CPA and financial advisor who specializes in Washington state tax planning. David and my partnership on this article took our combined expertise to develop and authenticate these strategies, and that type of partnership is what you should look for when implementing them in coordination with your CPA and financial advisor. All of these strategies involve added layers of financial, tax, and legal complexity beyond what is covered in this article.

Conclusion

This new legislation means investors will retain a smaller portion of their investment returns unless proactive steps are taken. Utilizing these core strategies could help mitigate the overall impact of the tax. As additional tax-efficient structures and planning opportunities emerge, we will continue to share updates to help safeguard your wealth.

FAQs

1. How does the Washington State 9.9% tax impact high-net-worth investment portfolios?

Answer:

The Washington State 9.9% income tax applies to individual net income exceeding $1 million (or $1 million for married couples filing jointly). For high-net-worth investors, this creates significant tax drag on non-exempt investment returns, including interest, dividends, and short-term capital gains realized in taxable brokerage accounts. To minimize tax drag, investors can utilize strategies like transitioning to Washington-issued municipal bonds, tax-lot selection, direct indexing, and strategic asset placement across tax-deferred or tax-free accounts.

2. Are Washington State municipal bond funds exempt from the 9.9% tax?

Answer:

Yes. Interest income generated from in-state Washington municipal bonds remains exempt from both federal income tax and Washington state income taxes. Reallocating fixed-income holdings from non Washington State Munis, taxable corporate bonds, or high-yield savings into Washington municipal bonds can be one of the most direct strategies to lower state-taxable passive income.

3. Can Donor-Advised Funds (DAFs) reduce taxable income under the WA Millionaire’s Tax?

Answer:

Yes, but with specific limitations. Contributing appreciated assets or cash to a state domiciled Donor-Advised Fund (DAF) or Charitable Remainder Trust (CRT) allows investors to claim a state charitable deduction to help lower net income below the $1 million tax threshold. However, investors should account for the $100,000 annual state charitable deduction cap when structuring multi-year giving strategies.

4. How does direct indexing help high earners manage Washington state income taxes?

Answer:

Direct indexing allows investors to own individual stocks within an index rather than a pooled ETF or mutual fund. This structure provides granular control to harvest individual stock losses year-round (tax-loss harvesting), which can offset taxable gains and keep total reported income closer to or below the $1 million threshold.

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Authors

Garrett Grigas CFA, CFP®

‍Senior Financial Advisor and Managing Partner Gevers Wealth Management

Garrett@geverswealth.com

David Halfhill CPA

‍Senior Tax Manager Sweeney Conrad

Dhalfhill@sweeneyconrad.com

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